Download 6 pages

Price Ceilings
Economics 101 –
Section 5
„
Governments sometimes intervene in markets, in
response to dissatisfaction from some groups in
society, by instituting price ceilings or price
floors. This intervention can have unintended—
unintended—
and sometimes harmful—
harmful—consequences.
Lecture 8
February 10
Government Intervention
Price Elasticity of demand
Figure 1 Price Ceilings in the Market for Maple Syrup
Price ceilings
„
When quantity demanded and quantity
supplied are different the shorter side of
the market will prevail
„
„
Price
per
Bottle
T
$4.00
That is, which is smaller of quantity supplied and
quantity demanded
E
3.00
A price ceiling creates a shortage and
increases the time and trouble required to
buy the good
„
S
R
2.00
D
While the price decreases the opportunity cost may
rise
4,000 5,000 6,000
• Possible emergence of a black market
Price floors
„
Price floor
Is a government imposed minimum price in
a market
„ Example of loan rates in US agriculture
„
• Prices are usually set above the equilibrium and
this causes excess supply
• To maintain the price floor the government must
prevent the excess supply from driving down the
market price
• To deal with the excess, the government often
purchases the excess supply.
V
Number
of Bottles of
Maple Syrup
Price floors and ceilings
„
Note:
A price floor below the market equilibrium
would have no impact on the market
„ A price ceiling above the market price would
have no impact on the market
„
• Remember to draw the effective price
floor above the equilibrium price and an
effective price ceiling below the
equilibrium price
1
Taxes (excise tax)
„
Taxes (excise tax)
Excise tax – is a tax on a specific
good or service
„
• If government imposes a tax of $100
then this will cause a shift in the supply
curve to shift up by $100
• The key here is on a specific good
• Examples include cigarettes, alcohol,
airline tickets, gasoline
„
Example – Airline tickets
Note that these taxes do not change with
the price of good
• i.e. the tax for cigarettes does not depend on how
much you paid in the store (do not confuse this
with sales tax)
Figure 4 The Market for International Air Travel
Elasticity
Price
per
Ticket
S´
„
$800
B
730
700
A
D
10
11.3
Tickets
(Millions
per Year)
Elasticity
„
Price elasticity of demand
„
„
„
measures the sensitivity of quantity demanded to a
change in price.
The greater the absolute value of this number, the
more sensitive quantity demanded is to price.
Demand can be classified as inelastic,
unitary elastic, or elastic.
„
„
Elasticity
• Elasticity measures the sensitivity of one
variable to a change in some other variable.
• Slope is not a desirable measure of sensitivity
because slope does not take into account the
relative size of the changes occurring.
• Elasticity is a better measure of sensitivity
because it does take the relative size of the
changes into account.
S
A special case of inelastic demand is perfectly
inelastic demand, shown by a vertical demand curve.
A horizontal demand curve shows perfectly elastic
demand—
demand—a special case of elastic demand.
Elasticity
„
The price elasticity of demand (ED)
for a good is the percentage change
in quantity demanded divided by the
percentage change in price
ED =
%∆Q D
%∆P
2
Elasticity
„
Elasticity
Calculating the elasticity
%∆Q D =
% ∆P D =
„
Calculating the elasticity
( Q1 − Q0 )
⎛ Q1 + Q0 ⎞
⎜
⎟
⎝ 2 ⎠
( Q1 − Q0 ) ( Q1 − Q0 )
⎛ Q1 + Q0 ⎞ 1
⎜
⎟
( Q + Q0 ) ( Q1 − Q0 ) ( P1 + P0 )
⎝ 2 ⎠ 2 1
ED =
=
=
x
( P1 − P0 )
( P1 − P0 ) ( Q1 + Q0 ) ( P1 − P0 )
1
⎛ P1 + P0 ⎞
( P1 + P0 )
⎜
⎟
2
⎝ 2 ⎠
( P1 − P0 )
⎛ P1 + P0 ⎞
⎜
⎟
⎝ 2 ⎠
Figure 5 Calculating Price Elasticity of Demand
% ∆ QD
Movement Along
Demand Curve
Point Ato
Point B
Point Cto
Point D
%∆ P
(500,000 – 600,000)/650,000
Elasticity
Elasticity of
Demand
($1,500 – $1,000)/$1,250
– 18.2%/40%
= – 0.182
or – 18.2%
= 0.40
or 40%
= – 0.46
(100,000 – 200,000)/150,000
($3,500 – $3,000)/$3,250
– 66.7%/15.4%
= – 0.66 7
or – 66.7%
= 0.154
or 15.4%
= – 4.33
„
A straight line demand curve can be used to
show that elasticity changes as we move along a
demand curve.
„
Price
per
Laptop
$3,500
3,000
D
C
„
2,500
2,000
When demand is price inelastic, total expenditure
moves in the same direction as price.
B
1,500
„
A
1,000
„
D
100,000 200,000 300,000 400,000 500,000 600,000
Figure 7 Extreme Cases of Demand
Since equal dollar
increases (vertical arrows)
are smaller and smaller
percentage increases . . .
3
2
When demand is price elastic, total spending moves in the
opposite direction as price.
When demand is unitary elastic, total expenditure remains
the same as price changes.
Quantity
of Laptops
Figure 6 Elasticity and Straight-Line
Demand Curves
Price
This happens because elasticity is generally not a
characteristic of a demand curve, but rather is a measure
of price sensitivity for a particular price change along that
curve.
(a)
. . . and since equal quantity
decreases (horizontal arrows)
are larger and larger percentage
decreases . . .
D
$4
$4
3
Perfectly Inelastic
Demand
1
. . . demand becomes
more and more elastic
as we move leftward and
upward along a straight
line demand curve.
D
(b)
Price
per
Unit
Price
per
Unit
2
2
1
1
20
40
60
80
100
Perfectly Elastic
Demand
3
D
20
Quantity
40
60
80
100
Quantity
Quantity
3
Table 1
Effects of Price Changes on Expenditure
Where demand is:
A price increase will:
A price decrease will:
Inelastic ( |
| < 1)
| = 1)
unitary elastic ( |
increase expenditure
cause no change in
expenditure
decrease expenditure
decrease expenditure
cause no change in
expenditure
increase expenditure
elastic ( |
| > 1)
4